Fed Bridges Gap to Earnings Pickup in Modest U.S. Growth

May 10 (Bloomberg) -- Company financial reports are showing
little improvement in demand. The Federal Reserve’s third round
of stimulus could boost prospects for faster sales gains in the
second half of this year.

With modest economic growth weighing on results, revenue
for companies in the Standard & Poor’s 500 Index has missed the
aggregate analysts’ estimate by about 0.7 percent, according to
data compiled by Bloomberg, even though earnings have been
better than projected. Through yesterday, 452 of the benchmark-index members have reported for quarters ending between Feb. 16
and May 15.

Amid “a languor” that’s set in about the U.S. expansion,
the Fed’s bond-buying program is “bridging the gap to a better
operating environment,” said John Manley, chief equity
strategist for Wells Fargo Funds Management, which advises on
$221.2 billion in assets in the Wells Fargo Advantage Funds. The
Fed is purchasing $85 billion of Treasury and mortgage debt a
month, in its third round of quantitative easing.

The central bank “won’t stop pumping money into the
economy until it’s clearly doing better,” which helps explain
investor optimism for second-half corporate revenue, Manley
said. Meanwhile, companies “haven’t run out of rabbits in a
hat” to cut costs, so there’s the potential for earnings
leverage if sales improve because companies have done a good job
of reducing excess spending, he said.

S&P Rise

Investors have brushed off the recent company reports to
push the S&P 500 up 4.1 percent since April 8. They’re
encouraged by signs that demand hasn’t weakened further and the
moderate expansion hasn’t derailed earnings.

Caterpillar Inc. has outpaced the S&P 500 by about 7
percentage points since April 19, the trading day before the
Peoria, Illinois-based company reported first-quarter results
that missed consensus analyst estimates and cut its 2013
forecast.

“Without a doubt it was a challenging” period, Corporate
Controller Michael DeWalt said on an April 22 conference call.
“We lowered production schedules, we’ve had rolling plant
shutdowns at a number of facilities during the fourth quarter
and continued that in many facilities in the first quarter.”

The 5.2 percent aggregate earnings surprise was achieved
largely by tight cost controls, said Leo Grohowski, chief
investment officer of New York-based BNY Mellon Wealth
Management, which oversees $188 billion. Concerns about the
“anemic economy” have caused business leaders to be very
cautious about increasing inventory, hiring employees or
undertaking capital-spending projects, he said.

Expanding GDP

Gross domestic product expanded at a 2.5 percent annualized
rate in the three months ended March 31, following a 0.4 percent
gain in the fourth quarter, according to the Commerce
Department. Growth was slower than the 3 percent median estimate
of economists surveyed by Bloomberg.

“There’s been a good deal of skepticism out there,” and
recent corporate earnings emphasize that “things aren’t great
right now,” Grohowski said. What’s more important to investors
is the prospect for a second-half acceleration, in which “a
great deal of pent-up demand is unlocked,” fostering higher
revenue and faster earnings growth, he said.

The U.S. economy will expand 2.2 percent in the third
quarter and 2.6 percent in the fourth, according to a Bloomberg
survey of 73 economists from May 3 to May 8.

Bullish Sentiment

Companies from MasterCard Inc. to Rockwell Automation Inc.
have said the last six months of 2013 will be better than the
first, supporting the bullish investment sentiment.

The first quarter largely was one of “delayed
gratification,” as many businesses that are most sensitive to
economic improvement didn’t materially change their full-year
guidance, said Ron Sloan, who oversees about $12 billion as
chief investment officer of Atlanta-based Invesco Ltd.’s U.S.
core equity team. Sales-estimate misses also “weren’t that
significant for the most part,” so “it’s too early to give up
on the year for cyclical stocks.”

Shares of industrial companies have held up decently amid a
“punk earnings environment’ that’s been ‘‘uniformly
disappointing,” Sloan said.

Parker Hannifin Corp., a maker of pumps, valves and other
products, continues to “perform very well despite a challenging
global-growth environment,” Chief Executive Officer Donald
Washkewicz said on an April 25 conference call. Even after North
American orders for the Cleveland-based company fell 10 percent
in the three months ended March 31, they appear to be “bouncing
off the bottom.”

Missing Estimates

Parker Hannifin’s stock has risen 4 percent since April 24,
the day before it announced fiscal third-quarter net sales of
$3.31 billion, missing the consensus analyst estimate of $3.35
billion. That compares with a 3 percent gain in the S&P 500.

There are about seven months left in the fiscal year for
many S&P 500 members, giving them time to recoup lackluster
results, Sloan said.

Even so, “there’s still a great deal of uncertainty out
there,” including a “lingering fear of a spring or summer
slowdown,” Grohowski said. “Companies are playing it close to
the vest.”

While investors may be optimistic about the second half of
the year, “there’s no evidence that growth is accelerating,”
said Barry Knapp, head of U.S. equity strategy in New York at
Barclays Plc. Earnings for the members of the S&P 500 are
projected to rise 7.2 percent this year amid sales gains of only
2.5 percent, he said, citing figures compiled by Barclays.

Further Cuts

Full-year profit forecasts already have come down from as
high as 10 percent, Knapp said. Barring a faster economic pace
that would boost sales, “it looks like earnings-growth
estimates will get cut further.”

There have been “some hopeful signs” among a mixed bag of
economic indicators, Sloan said. Employers added 165,000 workers
in April, more than the 140,000 forecast in a Bloomberg survey
of economists, Labor Department data show. The U.S. trade
deficit narrowed 11 percent in March to $38.8 billion from a
revised $43.6 billion in February, the second-lowest level in
three years, according to the Commerce Department.

Corporate sales probably will improve before the Fed halts
its Treasury-buying program, Manley said. The central bank’s
goal of sparking a “classic chain reaction” is showing
traction in the equity market, while indications from companies
“that nothing has changed” support the bull case that revenue
growth could improve later this year, he said.

In the meantime, companies have shown discipline managing
expenses as soon as they hit a soft spot, Sloan said. To make up
for missing sales estimates and keep margins alive, many were
“rolling into a ball to survive,” like “when a possum sees a
wolf.” Recently, executives are expressing more optimism, which
encourages investors.

“Some companies are starting to unwind from the fetal tuck
position,” Sloan said.